Question

List and define fiscal policy time lags and explain why they complicate efforts to engage in fiscal
“fine-tuning.”

Answer 1

There is some time between a particular action and when its impact is felt and this duration determines the extent to which the fiscal policy will be effective. The 3 major lags are

1. Recognition lag-This is the interval between when the action is needed and when it is recognized. This can be reduced if the forecasting tools and techniques are satisfactory.

2. Administrative lag -Interval between the need of action and when the action is actually taken. It is the most difficult lag to deal with and can take anywhere from 1 to 15 months. For reducing this lag public works need to be ready and red-tapism has to be reduced drastically.

3. Operational lag -Interval between when action is taken and when it has an impact on the economy, income, and employment.

The lags make the implementation and policy decisions very difficult as inside lag is short in monetary policy but the outside lag is short for fiscal policy. That is Congress or the government authorities take a long time to decide an appropriate policy but once implemented it takes a short time for people to respond. In the recognition lag, they mostly review past data which states about the event of the past hence backward-looking, and this analysis of data and review takes weeks in order to recognize any business cycle fluctuation. After recognizing the fluctuation the Congress has to debate discuss the measure has to pass a law, get it signed which again delays the operational impact of the policy. Hence the lags affect the fiscal policy implementation.